Tokenizing Metals - An Overview

DeFi continues to explode in popularity, driving most of crypto’s growth, but what some investors don’t realize is that it’s merely a continuation of crypto’s vision of “tokenizing the world.”

If you’re not familiar with the term “tokenization” yet, don’t worry: with this post, we aim to get you up to speed on what tokenization is, through precious metals, ending with an argument as to why the tokenization of metals matters.

What Is Tokenization?

On the most basic level, tokenization is the process of putting a real-world asset or commodity on the blockchain, as in making it into a cryptocurrency. That means that in general, anything that’s represented with a cryptographic token (cryptocurrencies, ERC-20 tokens, and beyond), is considered to be a tokenized asset.

Where Smart Contracts Come In

If you know what an ERC-20 token is, then you know that it’s launched through and maintained by a smart contract. The same goes for tokenized assets since at face value, they’re essentially the same thing.

Truthfully, the creation and usage of tokenized assets was never truly viable at scale until this year, in which the spread of DeFi has shown how all sorts of tokenized assets could be created and moved in practice using smart contracts.

In the context of tokenized assets, you can think of a smart contract as simultaneously acting as a mint that creates tokenized assets, a vault that stores them (until they’re bought), and a system that monitors their movements.

To grasp how this is possible, it’s enough to understand the ERC-20 standard, which was the basis for most of the initial and many of the current leading smart contracts. Using these facts, it’s then far easier to understand just how easy it is to create a tokenized asset.

Maintaining one, however, is much more complicated since it involves complying with local and national regulations including KYC/AML laws. Still, through understanding what assets “should” be tokenized as well as what benefits tokenization brings, it’s easier to grasp why a tokenized future is the most likely one.

What sorts of assets are ripe for tokenization?

Generally, illiquid (hard to trade) assets are the ones that benefit most from tokenization.

This includes examples such as: art, real-estate, and precious metals because all of them are hard to trade, i.e., illiquid and expensive to own. Through tokenization, these asset classes become crypto tokens and therefore, as easy to trade as Bitcoin, Ether, or any other cryptocurrency that exists.

That means that by extension, they’ll also be opened to up to the world-at-large, which means a much wider investor base, unless the platform that hosts the resultant crypto tokens chooses to impose strict requirements on who can and can’t use its services.

The same goes for any sort of tokenized asset, since they’re nothing more than cryptographic tokens, which are often hosted on a large, well-known blockchain like Ethereum. Consequently, on paper, the only barriers to entry for tokenized assets are those that their issuers have to follow based on the locales in which they operate. In other words, a cryptocurrency exchange that operates in Norway still has to follow regulations set by Finanstilsysnet as well as all other applicable laws regarding the assets it hosts and who it allows to access them.

Even so, tokenization is still worth it for both these issuers and the investors they serve, due to the unique benefits it offers. To understand why, consider the upsides of tokenization.

What are the benefits of tokenization?

To put it simply, the benefits of tokenization are equal to the benefits of using a cryptocurrency over traditional money, assets, or commodities. In all of these cases, a cryptocurrency allows for far easier and greater liquidity, much faster transaction settlement times, and the high level of transparency that only the blockchain can offer today. The same goes for “tokenized assets.”

Consider a house.

Is it tradable?

Can it be moved around as quickly as a stock, or even a cryptocurrency?

Unless recently, the answer to both of these questions has always been now.

Now, assets like property, which were previously non-divisible can be put on the blockchain and be divided into as many cryptocurrency tokens as the issuer wants. This means that a previously non-divisible asset has become divisible and a previously untradable asset has become tradable.

If you consider the fact that the global real-estate market’s value is currently estimated at over $10 trillion, then you’ll see the general potential of opening it up to trading or giving it true liquidity for the first time in history. As we’ve seen with the crypto space, once an asset becomes globally available for the first time in history, true markets and therefore, true price discovery can be made.

Therefore, it can be argued that one of the primary benefits of tokenization is democratizing access to an asset, which can consequently raise its value over time.

The Case for Tokenized Metals

The real estate market is far from the only one that stands to benefit considerably from tokenization. Consider, for example, precious metals or more specifically, gold.

For centuries, gold has been used as an investment vehicle and yet, it’s complicated to move and difficult to store. As if this wasn’t enough, today, most of the world’s gold supply is either held by national banks as a reserve asset or by brokers who represent one of the only parties who can directly sell gold to the average investor.

Eliminating Rent-Seeking from Brokers

Because brokers are effectively the only party that an investor can turn to if they want to purchase real gold, they’re able to charge premiums of up to 30% on top of the true cost of the gold they’re selling. On top of this, many of these brokers set initial investment minimums of $2500 or more, which vary based on the minimum ounces of gold a broker is willing to offer. By default, constructing this sort of gateway locks out inventors who don’t have the capability to provide that kind of capital up front, all at once.

These practices, together, may be termed “rent-seeking,” which refers to extracting exorbitant profits from effectively manipulating access to something valuable.

With tokenization, this rent-seeking becomes all but impossible since the heart of the cryptocurrency movement is the ability to move money and other assets at near-zero costs as compared to the legacy financial system. Keeping this in mind, investors will be able to take the true price of an ounce, gram, or kilo of gold, or its “spot-price” and compare it to the price that a broker is charging to see if they’re being cheated.

Projects like DGLD, Cache.Gold (CGT), and Pax Gold, among others, are already illustrating just how fair tokenized gold can make the gold markets through negligible fees and instant liquidity (you can trade tokenized gold as easily as any cryptocurrency).

Though it’s early yet, gold brokers will all eventually be replaced by “neo-gold brokers” who simply issue tokenized gold and store its equivalent physical gold reserves, once the practice of tokenizing gold becomes truly widespread. The practice of buying, selling, and trading gold could then truly become democratized at a global scale.

Erasing Fraud Through Blockchain-Based Tracking

On top of making metal brokers obsolete, tokenizing precious metals like gold makes fraud all but impossible, if the movements of a tokenized asset’s metal reserves are consistently tracked and reported on the blockchain. Typically, this is done by scanning the gold with an RFID scanner which then sends its location and ownership data to the blockchain so that at any time, these factors can be verified. With this, it should be noted that this is less of a norm in the tokenized asset space and more of an ideal. Still, since it promotes end-to-end transparency and therefore, increased user confidence, such a state is one that all tokenized asset issuers should aspire to.

All of the above, in turn, applies to the tracking of a tokenized gold issuer’s reserves (the real gold that backs their tokens). In other words, if they say each token is backed by a gram of gold, then that should be provable on the blockchain as well, through consistently recorded audits.

Proving Legal Status on the Blockchain

Through posting their legal statuses on the blockchain, tokenized asset issuers can attract non-crypto native investors, who are used to being able to easily check the legal standing of any institution they leave their money or assets with, at any time. Projects like Blockcerts have already demonstrated just how easy this is to do in practice.

Any credential can be tokenized, just like gold, and then receive its own public and private keys to effectively be held in a cryptocurrency wallet. From there, anyone who possesses its unique URL (equivalent to something like a receiving address) can access it and verify its authenticity. While to date this tech has mostly been used for diplomas or professional certificates, its utility could easily be extended to the relevant licenses for any sort of financial services provider, including those who maintain tokenized gold and its reserves.

Those “tokenizers” who choose to follow this practice will likely lead the spaces they’re in over time since generally, the average person values being able to prove that their financial service providers are trustworthy.

Reducing Price Suppression

If all of the above is carried out, then the current supposed practices of price suppression on the gold market should become much harder to carry out, especially if the bulk of the world’s gold gets tokenized on public blockchains like Ethereum or Bitcoin.

If that were the case, then any activity related to price suppression could easily be tracked using tools like Chainalysis and reported to the corresponding authorities.

What are the risks of tokenizing assets?

As we’ve pointed out above, not all assets should be tokenized.

If an asset’s already easy to buy, sell, and trade(liquid) and those processes work well, then there isn’t such a strong case to put it on the blockchain as with gold and property. If you’ve been in the cryptocurrency space since 2017, then you’ve already witnessed countless projects try to tokenize things that have no business being tokenized and end up failing.

Even assets that “should” be tokenized could lose value once tokenization occurs at scale.

There’s something to be said for the value of scarcity. One of the only reasons that, for example, gold, diamonds, and other metals or jewels are valuable is that they’re hard to mine and generally just hard to find. If a massive supply of a metal or jewel was tokenized all at once, it could have a significant effect on that asset’s market price over the long-term. Whether or not that effect would be strictly negative is up in the air until such an event comes to pass.

Even so, when groups decide to tokenize assets that can benefit from tokenization, they should keep this risk in mind and look for ways to mitigate it like introducing digital scarcity into their offerings, which Bitcoin pioneered. Since all projects that aim to tokenize metals, jewels, or anything else at scale are still early-stage, it will be truly interesting to see how exactly they decide to proceed in this respect.

Tokenizing assets can increase the risk of them being used for nefarious activities.

To prevent newly tokenized assets from being used to fund illegal activities, issuers should be sure to follow local and national KYC/AML regulations as well as consider working with groups like Chainalysis, who specialize in monitoring possibly suspicious activities on the blockchain. Through doing so, the issuers and any applicable exchanges, as well as their users will be protected from any sort of legal recourse that can arise from the activities of a few bad apples.

Tokenized assets are as tradable as cryptocurrencies.

The greatest benefit that comes from tokenization lies in making a previously strictly physical(untradable) asset, as easily tradable as a cryptocurrency. Once something is tokenized, it exists as a cryptocurrency or token and has therefore been put on the same level with that which is crypto-native.

In other words, tokenized assets become as easy to move around as crypto-native assets like Bitcoin or Ether. This means being able to transfer the ownership of a traditionally physical asset in the time it takes to mine a block. Since that capability already exists through the projects we’ve mentioned above and more, we’re already one step closer to a future financial system that’s truly blockchain-native.

Who wins from tokenization?

Beyond the average investor, the other major party that wins from tokenization is the business that’s willing to completely overhaul its business model so that it can thrive in the face of the spread of tokenized assets. Going back to the example of tokenized gold, one case that effectively illustrates this principle is the broker who instead becomes a “tokenizer” and “storer” of both physical gold and its corresponding token.

Above all, this business, which you can think of as a “neo-broker,” like we described above, wins out because they’ve jumped ahead of most of the legacy financial system and opened themselves up to a new market of investors who are tired of the rent-seeking activities of the legacy financial system and looking for opportunities that they can actually consider to be “fair.”

Cryptocurrency exchanges currently make up a large part of these “neo-brokers” in that globally, they already offer the easiest access and widest liquidity to tokenized assets. At NBX, we believe the future financial system will be fully tokenized. Therefore, we’re consistently considering tokenized assets for listing on the NBX Exchange, especially if they use the value of the blockchain to redefine their business models, while giving both retail and corporate investors new ways to invest in the cryptocurrency space.

Through continuing to analyze and spread the word about tokenized assets and other key topics across the cryptocurrency space, we aim to do our part to educate investors of all levels on the future of finance as we see it. If that interests you, stick with us on this blog and we can pave the way to a tokenized future together.

Norwegian Block Exchange (NBX) is a pioneering, forward-thinking and client-oriented Norwegian cryptocurrency exchange, custodian and payment system. Trade with us at nbx.com, follow us in Twitter or Facebook📲✔️

Disclaimer: Content provided does not constitute as financial advice.

Also published at https://medium.com/norwegian-block-exchange/what-is-tokenization-the-case-for-tokenized-metals-64cf0187c971